“In markets, economics, and crises; things take longer to happen than you think they will, and then they happen faster than you thought they could.” – Ritesh Jain
2017 was a tough year for many rational, sane investors who had to keep chasing the non-correcting ascent.
And now, as Sven Henrich notes, 2018 has turned out to be a year for Wall Street to be wrong on everything. The year when the warning signs finally did matter, but they were ignored:
A perhaps similar script to 2008 when the warning signs then were ignored as well only to see the largest financial crisis in our lifetime unfold:
And now, as Bloomberg notes, 2019 is shaping up to be a testing year for the world economy.
By far the biggest concern heading into 2019, according to BofAML’s sentiment survey, is the resumption of trade concerns.
And that is expected to weigh on growth…
Bears will argue that while the U.S. and China have agreed a temporary truce to their trade war, the peace won’t hold. That means risks of new tariffs and other barriers between the world’s two biggest economies remains heightened.
Bulls argue there’s a deal to be done. Trump and Xi will agree terms that allows greater access to China’s markets without China surrendering its grand ambitions to create a world leading high tech economy.
2018 definitely saw a regime change from what investors have become used to as BTFD morphed into STFR and the smart money dumped like never before…
If the only ‘money’ keeping stocks alive is ‘buybacks’, 2019 could be one for the ages, as Sven Henrich notes:
“And while markets may still see sizable rallies, the warning signs are still all around us, and they send a clear message: The 10-year bull market will come to an end, and the investing and trading climate is changing dramatically, possibly, for years to come.”
And one of the biggest factors in whether 2019 is “it” lies in the energy complex. Oil prices enjoyed a wild ride in 2018, ending the year around $50 a barrel, after hitting more than $75 in October.
Bears argue lower prices reflect weak demand and still-booming supplies from U.S. shale formations that will hurt energy-reliant economies.
Bulls say cheaper energy will cushion consumers, countries with current account deficits and will keep a lid on inflation, giving central banks less of a reason to raise interest rates. Oil production cuts of 1.2 million barrels a day by OPEC and its allies won’t hurt either.
Central Banks began to spoil the party in 2018 and 2019 is set to accelerate things.
Bears argue liquidity will become more expensive as central banks raise interest rates led by the Federal Reserve. That means more emerging market turmoil right as populism is pressuring central banks.
Bulls argue there’s no inflation so there’s no need for higher interest rates. Moderating U.S. growth means the Fed can pause.
Instead of the U.S. economy breaking the record for its longest expansion, bears see 2019 as the year growth goes in reverse. A fading fiscal stimulus, Congress paralysis, trade wars and Fed hikes will hurt.
Or maybe not. Bulls note that there’s no sign of overheating or rampant inflation that could derail the economy, and employment remains solid. And the Fed could decide to pause earlier than markets currently expect, easing pressure on borrowers and markets.
Credit market concerns are quickly becoming a key subject to fear as liquidity fades driving up the cost of funding for all as a boom in issuance of structured products such as collateralized loan obligations has spurred warnings from regulators.
Bears worry that a weakening economy and Fed liquidity withdrawal could wallop credit fundamentals, flipping many BBB credits into junk territory.
Bulls say with the Fed’s rate-hike campaign coming to an end, and a recession avoided, returns will return to positive in 2019. Bank of America Merrill Lynch sees U.S. leveraged loans posting total returns of between 4 and 5 percent.
And while a lot of focus is on China (trade and economy) and US, Europe will be key too.
Bears say the Italian government’s open defiance of European budget rules will spark the euro’s next crisis. The European Central Bank could be forced to intervene with untested tools, pressuring the fragile political consensus holding the euro together.
Bulls argue support for the euro is at a record high in Italy and the rest of the euro area. The populist government has signaled it wants to find a compromise with European partners. Street protests in France calm down without leaving permanent damage.
And of course Brexit may be the ultimate arbiter of Europe’s direction with the U.K. potentially crashing out of the European Union next year.
Bears note that The Bank of England warned that such a scenario would see the economy shrink as much as 8 percent and the pound lose a quarter of its value. In a no-deal Brexit, financial markets enter panic mode.
Bulls argue Brexit can happen orderly and both sides can make quick progress in defining their new economic relationship.
And finally, Debt and Rates remain a key factor for 2019 and investors now overwhelmingly believe The Fed pauses its interest-rate-hiking regime in the first half of 2019…
Which is echoed in the collapse of market-implied expectations for Fed rate moves over the next two years…
Bears note that global debt is now more than three times the level it was 20 years ago, raising concerns the world is headed for a debt crisis. They note that rising interest rates pose significant risk to households and nonfinancial firms in 36 percent of sizable economies. They warn that most advanced economy governments and several large emerging markets are highly vulnerable to sovereign debt risks.
Bulls say interest rates will only crawl higher and as long as economic growth holds up, borrowers can service their debt.
However, as BofAML notes, something notable has change in recent weeks. Duration positions in Treasuries have adjusted dramatically, crossing into net long exposure for the first time since 2016, and reaching a level not seen in our data since 2010. Furthermore, UST vs core Europe positioning is at a record level in our data since 2004.
The driver of that sharp adjustment seems to be the expectation that US growth will slow sharply to converge to a less buoyant global economy. However, to validate these longs, the Fed will not just have to pause, but stop hiking altogether… and trade war concerns will have to come true – which brings us full circle to the start of this summary.
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